WILL THIS REIT FLY? INVESTORS QUESTION A GIANT INDUSTRIAL DEAL

A Chicago real estate company, First Industrial Realty Trust Inc., is meeting sharp opposition from institutional investors as it presses forward with a $440-million initial public offering.

If successful, First Industrial would be the largest U.S. real estate investment trust (REIT) made up of industrial properties, with a total debt-and-equity capitalization of more than $700 million. The REIT is a vehicle for Hawaiian real estate magnate Jay Shidler to securitize his Midwestern industrial holdings.

Mr. Shidler, 48, is no stranger to the public securities market. Last year, he launched TriNet Corporate Realty Trust Inc., a San Francisco-based REIT consisting of specialty commercial properties, which has been one of the best performers of last year's bumper crop of REITs.

However, financial intricacies incorporated in the First Industrial offering have raised the ire of institutional investors, who remain leery of the resurgent REIT market.

In particular, institutional investors have bitterly criticized the structure of a deal to reduce the interest rate on a $300-million loan to be secured by 200 of the REIT's properties.

First Industrial will pay a $25-million upfront fee to obtain a two-percentage-point reduction in the mortgage rate over the next five years.

Critics say that by amortizing the fee-in addition to using the rate reduction to improve profitability-the deal may overstate a key REIT financial measure called "funds from operation" (similar to cash flow) and inflate the pro forma value of the REIT by as much as $50 million. Even so, the accounting method is proper.

The interest rate on the seven-year loan would float for the remaining two years of the term, creating a potential time bomb for investors if interest rates rise significantly.

Other criticism: Nearly half of the properties in the REIT were acquired recently, or will be at the time of the offering, meaning management has little track record leasing and operating the buildings.

Moreover, the REIT sponsors, including Mr. Shidler, will receive cash payments of $7.5 million as part of the deal.

Mr. Shidler and Michael Tomasz, chief executive of First Industrial and a longtime player in the Chicago industrial real estate market, would not comment last week due to federal prohibitions against pre-offering publicity.

The two executives begin a series of road shows for institutional investors this week. The deal could change before the offering in June.

Based on interviews with sources close to the offering, a key aspect of First Industrial that Messrs. Shidler and Tomasz are likely to pitch to institutional investors is its ability to grow quickly, mostly by borrowing. The REIT expects to acquire $200 million of industrial property in the year after the offering.

The two executives also will tout a nine-member board dominated by independent directors, including John Rau, former CEO of Chicago's LaSalle National Bank and now dean of the Indiana University School of Business.

The First Industrial offering is coming to market at an opportune time, with industrial property rents rising and vacancy rates falling.

In March, Security Capital Industrial Trust, a REIT controlled by former Chicago real estate executive William Sanders, came to market in a well-received initial public offering. Security Capital's stock price has appreciated more than 40% since the offering.

"You're going to see a lot of industrial activity in the REIT market because it's the only major property type, other than office, that has not yet seen massive securitization," says John S. Gates, chief executive of CenterPoint Properties Corp., a Chicago-based industrial REIT.